Government Spending Debate Affects Politics, Economy

That sharp drop in government spending that put the squeeze on the economy last quarter, as we just heard, is likely to be repeated. This spring, the government is set to make additional cuts to spending, including defense, unless lawmakers agree on a different plan. So far there's little agreement in Washington about the optimum size or shape of government spending.

NPR's Scott Horsley joins us now to talk about this in our Business Bottom Line. Good morning, Scott.

SCOTT HORSLEY, BYLINE: Good morning, Renee.

MONTAGNE: So we sometimes speak about government spending as if it's independent of the broader economy, but really not the case.

HORSLEY: No, it's not. Government spending is a big part of the economy, nearly 25 percent last year. Now, most of that is passed through transfer payments that don't show up in the GDP numbers. For example, when the government sends my mom a Social Security check and she uses some of that money to go out to a restaurant, that shows up as my mom spending the money, not the government spending the money.

But what is counted as government spending in the GDP numbers is what the government itself spends on goods and services for research or road building or, significantly, defense contracts. In fact, the lion's share of the government spending in GDP is for defense, and so when that contracts, as it did in the fourth quarter, people take notice.

Had defense spending merely stayed level in the last three months of the last year, we would have seen modest economic growth.

MONTAGNE: And as we just said, there could be more defense cuts on the horizon, right?

HORSLEY: Right. When Congress passed the fiscal cliff deal at the end of last year, it didn't do away with those automatic spending cuts that have been looming, it just pushed them back for a couple of months. So we're still looking at tens of billions of dollars in spending cuts due to kick in in March, with half of that due to come from defense spending unless lawmakers are able to cut a deal before then.

If those cuts do kick in and are maintained for the whole year, forecasters say that could shave another seven-tenths of a percentage point or so off of economic growth in 2013.

MONTAGNE: Which sounds, a little bit(ph), can really put a drag on the economy, right. What are the odds of a deal to avoid that?

HORSLEY: Well, they're not looking all that good right now. Remember, when the automatic spending cuts were first agreed to back in 2011, they were meant to be a cudgel so onerous that they would force lawmakers into making a different kind of deal. Democrats thought that the defense cuts in particular would be so toxic to Republicans that they would insist on replacing them with something else, maybe even higher taxes.

But it hasn't necessarily worked out that way. Certainly Republicans are not thrilled with the prospect of deep defense cuts, for that matter neither is President Obama. He is, after all, commander-in-chief. But there hasn't been a whole lot of movement with just a month to go. And in fact it could have been anticipation of those kinds of cuts that contributed to the Pentagon scaling back its defense spending in the fourth quarter.

Although we should say that defense spending in the third quarter spiked as it often does at the end of the government's fiscal year, so some of that fourth quarter decline was maybe just payback for that.

MONTAGNE: Well, still, though, with this news that the overall economy shrank in the fourth quarter, is there some sense that government spending has been cut too much?

HORSLEY: Well, here we see a big partisan divide. Now, as Ellen Blinder noted in Jim Zarroli's story, government spending's been cutting back for a couple of years now and White House economic advisor Alan Krueger called yesterday's GDP report a reminder that Congress should avoid what he called self-inflicted wounds to the economy. But you know, one man's self-inflicted wound is another's therapeutic bloodletting.

Republican Senate Leader Mitch McConnell stood up on the Senate floor yesterday within hours of the GDP report and argued that what the government needs now is more spending cuts in order to avoid what he called a European-style catastrophe. Now, never mind that austerity measures in Europe have not exactly produced robust economic growth.

It is true that government spending as a share of the overall economy is larger than it's been historically. That is one factor in our federal deficit. What's also true, though, is that government tax receipts are smaller as a share of the overall economy than they've been historically, less than 16 percent in the last four years, and well below the level that produced balanced budgets back in the 1990s.